The Ticking Fiscal Clock

In this state and local fiscal mess, realism may be the only option.

Just off Times Square in midtown Manhattan, the electronic billboard called the "National Debt Clock" tracks the quickening progression of America's public borrowing. The contrast with the rest of the gargantuan signage in the area, blinking and twinkling the gaudy messages of hyper-commercialism, is poignant. Not long ago, the operator of the debt clock had to add a fourteenth digit on the left-hand side: The debt had soared past $10 trillion.

This country has been in denial about the looming debt crisis for some time, but we finally seem to be settling in on it as an overarching issue that will significantly affect the way the feds, states and localities govern in the foreseeable future. We have finally begun to grasp the fiscal realities of the precipitous collapse of the economy, the breath-taking cost of bailing out the banks and the projections for geometric increases in the national debt in even the short-term future.

The U.S. Census Bureau recently reported that American household income is taking its sharpest plunge in the half-century the Bureau has been measuring that statistic. Over this year and last, household income is projected to fall almost 9 percent, after adjusting for inflation. State income tax revenues have plunged precipitously in the past fiscal year and this one, forcing spending cuts of more than a quarter of a trillion dollars. Now, at least 15 states are cutting even more. And that's despite the fact that states are able to cover about 40 percent of their shortfall with federal stimulus money. For the first time, federal funds have become the largest source of money for states and localities, replacing sales taxes.

It isn't that states have relied on spending reduction alone. At least 30 of them have raised taxes this year, at an earlier point than has been common in previous recessionary cycles. The year-over-year increase in taxes is more than 3 percent. That is more than double what we saw the last time states were in trouble, from 2002 to 2003, but not as much as in the recessions of the 1980s and 1990s. So it stands to reason that we're looking at another round or two of tax increases in lots of states.

If all the economists who watch state and local finances are right--and that's always a gamble--state revenue growth over the next five to 10 years will be half the average of the past three decades. Don Boyd of the Rockefeller Institute in Albany predicts that revenues could take three to five years just to regain their 2008 levels.

Local governments, which weren't hurt so badly in the last recession because property taxes held up, have been hammered this time. A National League of Cities survey reports that optimism among city finance officers about their ability to meet their needs is at the lowest level in the survey's 24-year history.

Economists also are forming a consensus that the stimulus, however awkwardly and hesitantly, is working. The federal government has taken the role of a "first-round venture capitalist," as Ed DeSeve, the administration's chief overseer of the program, describes it. So far, the feds have worked their way through about half of their obligations, with another 18 months or so of activity left. There is little appetite in Washington for another round of stimulus, although the White House apparently is considering some added programs to promote job growth.

Still, at least the next two years look pretty gruesome for states and localities. We can anticipate some aggressive attempts to raise new revenues and control or slash costs. Expect to see a further expansion of gambling, attempts to open coastal areas to offshore drilling for oil and gas, and a push for privatization of such assets as highways, airports and municipal water-treatment facilities. But it's doubtful whether we'll see what economists have been advocating for years: rewrites of entire state tax codes so that they tax a wider range of economic activity but at generally lower rates.

Meanwhile, the problem of shaky public pension and health benefit plans needs to be addressed. Hard questions need to be asked about whether we can continue our role as the world's largest jailer. And we must begin to discuss whether we can afford any longer to pay for a public sector that is ridiculously fragmented, both vertically and horizontally.

In other words, governments at every level will have to ask what their core mission is--what services they must provide and which ones are desirable but not absolutely necessary. Of course, one citizen's necessity fits the definition of waste to another. So we're sure to have plenty of political brawls about that. But as we have spent massive amounts to pull ourselves back from the abyss--quite rightly--we now must fashion some new models for state and local government that are affordable and sustainable.

That electronic billboard in Times Square, with its numbers flickering by so fast they are hard to read, is a national time clock counting down the days until--barring some quick and decisive action--we are likely to face a terrible reckoning.